Banking Law and Practice

 

Various Types of Banking Nature, Scope, and Functions

 Types of Banks Banking is directly or Indirectly connected with country's trade and Individuals. An industry that manages Credit, cash, and other Financial Transactions. An influential Institution to run a country's economy.

 Basically there are Two Main Types of Banking; Commercial Banks and Central Banks 

➢ Commercial Banks 

➢ Agriculture and Cooperative Banks 

➢ Specialized Banks 

➢ Central Banks 

➢ Industrial Banks 

➢ Shadow Banks 

➢ Investments Banks 

➢ Credit Unions 

➢ Retail Banks

Brief Definition and Details

1. Commercial Banks: Play an important role in Modern Economic System. Provide short-term Credit. Regulated by their respective countries Regulation Act, accept public deposits from public for Lending or Investments. 

2. Agriculture and Cooperative Banks: Distribute cheap Credit to their members(farmers and community individuals), Back up Rural population for Financing 

3. Specialized Banks: they provide Financial help to Special Industries, Foreign Trade etc. See note.

4. Industrial Banks/Corporate Banks: these banks advance loans to Industrial undertakings. Provide Capital Credit for long periods. (buy machinery and equipment. Also receive deposits for long terms 

5. Central Banks: they manage, Check, and Monitor all the financial activities of Commercial Banks.

Management Hierarchy

How it works Institutionally;

Bank Manager s work on top in a bank branch Other staff normally include: 

• Investment Bankers 

• Equity Analysts

• Loan Officers, Bank tellers 

• Financial Accountants, 

• Chattered Public Accountants 

Five Cs of A Bank

There are certain standards normally a bank sets for its Lenders. The lender evaluates and determine whether they will make a loan in view of 

• Capacity 

• Capital 

• Collateral 

• Credit, and 

• Character

Functions of Banks

Two Main Functions of the Banks All banks basically perform Two functions; 

1. Accepting of Deposits 

2. Granting or Lending of loans or advances The primary functions or aims of banks include deposits, loans, advances, Cash, credit, drafts and discounting of bills while secondary functions include;

Issuing letter of credit, undertaking safe custody of valuables, providing consumer finance, educational loans etc.

As the primary role is deposits, they take in funds from general public and businesses, pool them and lend these to borrowers. Banks are basically intermediaries between depositors(who lend money to the bank) and borrowers(to whom the bank lends money) On the other hands providing safe custody for valuables, and important documents Securities by providing safe deposits vaults or lockers Standing guarantee on behalf of its customers

Latest Services by today's banks 

Modern day banks provide state of the art products and services in todays cut throat competitive era Salient features include; 

• Checking and Saving Accounts 

• Loan and Mortgage Services 

• Wealth Management 

• Providing Credit and Debit Cards 

• Overdraft Services

Banking Law & Practice

Banking Functions at a Glance 

• A network of institutions providing financial services to the public 

• Providing sense of financial security and confidence in the economy 

• Managing flow of funds between persons and business entities. 

• Earn from investments, interest on loans, and costs levied on consumers, currency exchange and wealth management

Central Bank Role and Functions in a country's Economy 

Central banks are financial institutions mandated to carry out regulations and oversight of all other banks. It is privileged to formulate all the monetary policies and regulations for other banks In most countries of the world including US and Europe central banks are the only provider of coins and currency notes in circulations The purpose of CBs is to stabilize currency by controlling inflation

CBs Role & Functions

CBs are the ultimate regulator of other banks and is not regulated by any superior bank. In other words it is all in all in charge and dominating bank in the whole banking sector of a country's economy. 

Other functions include; 

1. Issuance of money 

2. Lender of the last resort to other commercial banks 

3. Insuring the stability of financial systems 

4. Formulations of monetary policies.

5. Targeting Growth and Unemployment 

6. Lender of last resort to the governments Examples; State Bank of Pakistan, Reserve Bank of India, Federal Reserve Bank in the US, which are responsible for devising and conducting monetary policies, supervising and regulating other financial institutions.

Evolution of Banking Sector in Pakistan: 1947—to Date 

Banking started right from its inception in 1947. At time of partition 45 scheduled banks operating in Pakistan. Bank branches were in India, west and East Pakistan Foreign banks were limited and many of the banks” head offices were based in India Only Habib Bank and the Australia Bank run by Muslims moved to Pakistan The central bank activities were conducted by the Reserve bank of India until the central bank of Pakistan established in September 30th 1948

Banking History of Pakistan

The govt. of Pakistan passed an order to promulgate bank and as a result the State Bank of Pakistan established on July 1, 1948. Currency notes were released and the National Bank Ltd., was set up in November 1949.

Banking Companies Control Act was passed in 1948, defining the role that state bank would play. With increased demands for funds and growing business needs due to the industry revolution in 1950s and 1960s, the bank advanced and set up new institutions and with branch expansions.

History of Banking in Pakistan

By 1970, there were 1591 bank branches country wide while by 1972, Total number of scheduled banks were 14 operating in Pakistan. In 1974, all the banks were nationalized under the “Nationalization Act of 1974. There are three known Stages or Phases of banking sector in Pakistan.

 

1. Pre-nationalization, 

2. Nationalization, and 

3. Post-nationalization.

The volatile journey of Pakistan's banking

Banking sector in Pakistan has seen drastic changes since its inception through the developed and modern banking system of today. According to the constitution (1958, 1962, and 1973) the interest from banking sector was to be eliminated As the 21st century saw the emergence of Islamic banking across the globe. It facilitate d different sectors of the economy. Islamic banking proved a successful experience due to the growth and expansion of banking sector.

Establishment of Commercial Banking (1947-1973)

Pakistani banking sector has seen many ups and downs during this period of uncertainty between 1947 and 1973. Suffered from acute shortage of resources and uncertainty due to prevalent political and socioeconomic conditions. 

Untrained human resources and professionals resulted in poor quality of products and services. State bank of Pakistan was established as Central bank on July 1st , 1948.

SBP was set up for the purpose of controlling and regulating the financial sector. State bank of Pakistan Act 1956 was passed to extend the control and functions of banking to encourage the private sector to establish banks and financial institutions.

This step resulted in unhealthy competition and unlawful practices due to bribery and corruption during 1950s and 1960s. Gradually financial reforms and changes in governance the performance and quality of services and products of banking sector in 1992.

 

Nationalization of Banks (1974-1978)

All established banks were nationalized in 1974 by the then government which further deteriorated the sector due to govt., for employees It resulted in otherwise worse consequences which promoted bad practices and poor quality services and products.

Discouraged the private investors and foreign financial institutions. Drastic changes in banking sector were witnessed due to strong competition among public, private, and foreign banks. Private banks dominated during 1950 and 1960s, but were nationalized in 1974 due to fall of Dhaka and bad economic conditions. Banks proved very poor performance in terms of products and services that resulted again in privatization of banking sector in 1992.

Banking Law and Practice 

Islamization of banking Sector (1979-1992) The first Islamic bank was established in Egypt in 1963. The OIC (Organization of Islamic Conference) also supported the Islamic financial system in 1973 at Jeddah.

Similarly a number of Islamic banks were set up as Amanah Bank in Philippine in 1973 DIB (Dubai Islamic Bank) in 1975, The Faisal Islamic bank of Sudan in 1977, The Faisal Bank of Egypt in 1977, The bahrain Islamic Bank in 1979, and Meezan Bank in Pakistan in 2002, and in Malaysia, Islamic Banking Act was passed in 1983 to transform the conventional banks into Islamic banks. 

Efforts and Steps Taken for Islamization of Banking Sector

A number of steps were taken during (1979-1992) to introduce interest free products and services in financial sector, especially in banks In 1979, National Investment Trust (NIT), ICP, and HBFC started interest-free transactions.

In 1980 Mudharaba companies were introduced and established Participatory terms certificates was launched and Zakah Ordinance was announced. In 1981 nationalized banks were required to open interest-free accounts for their customers. Usher Ordinance came into force in 1983 throughout Pakistan.

Islamization of banking System

In the same year financial services Ordinance was amended to introduce interest-free financing SBP was assigned the duty for transition of interest based financial institutions into interest-free ones by 1985 In 1990s Islamic banking practices were established all over the world especially in the Muslim populated countries, In December 2001, SBP issued detailed criteria for establishing of full-fledged Islamic bank in private sector.

First Full-fledged Islamic Bank 

Al Meezan Investment Bank was the first Islamic Bank whom SBP issued license for in January 2002, and started its operations with the name of Meezan Islamic bank as the first Islamic bank on March 20th, 2002. However these efforts did not achieve its goal due to a number of reasons 

• Transitional process was revolutionary instead of evolutionary, 

• Lack of flexibility due to strict system 

• Lack of appropriate Shariah compliance mechanism 

• Lack of interest from stakeholders

Privatization Process of Banking (1992-2000)

• In 1990s financial liberalization and deregulation encouraged local investors foreign banks 

• Stimulated competition among banks due to expansion in banking industry, 

• many private banks started operations and tried to attract maximum number of customers, 

• Govt., ownership was discouraged due to lower financial development , low productivity, and slow economic progress, 

• State owned banks were unable to monitor progress due to absence of clear objectives and responsibilities

Privatization Process

• Privatization may not be successful due to the limitations and environmental constraints of a specific economy, 

• Reports say that privatization of banks in low and middle income countries did not get the required results due to overstaffing and debt burden(Orchere 2003) 

• Financial liberalization and privation in Pakistan has not achieved its goal so far of financial growth and development in the banking sector.

Current Situation of Pakistan's Banking Industry  

Banking sector has seen continuous improvement with diversified pattern of ownership due to active participation of foreign and local stakeholders. Increased competition among banks to attract customers, quality services for long term benefits. 

6 full-fledged Islamic banks and 13 conventional banks offering services compliant with Shariah principles. Reports say Islamic banks” customers have greater perception of service quality compared to conventional banks” customers (Ahmad et al. 2010)

Current situation

Customers awareness and sense of better choices have greater impact on banks” performance. Greater consideration for customer satisfaction and priorities. Due to increased competition the customers may switch over to other banks if they feel with existing ones.

 Islamic banks are more appealing by offering Shariah compliant products and services. Created expansion in its network, size, and structure due to exquisite blending of commercial banks, micro finance institutions, and Islamic banks in the country. 

Concluding Remarks and Emerging Trends 

Financial sector role ensures smooth functioning of an economy. Directs resources to the real sector by helping capital formation and facilitating financial transactions. A sound and stable financial system is a pre-requisite for economic development. 

Pakistan's financial sector is consisted of bank and non-bank financial intermediaries including commercial banks, specialized banks, and micro finance banks while non-bank intermediaries include development finance institutions, and insurance companies 

Concluding Remarks 

The financial sector overall assets amount to 75% of the GDP as of Dec 2017. The State bank of Pakistan and Security and Exchange Commission of Pakistan are the apex institutions regulating the financial system.

Banking Law and Practice, Lecture No 7 Banker-Customer Relationship The Essence of Relationship and what is a Banker: Although the essential features of banking business are well known but still it has been defined differently in various legislations of the world. j. W. Gilbert in his book “Principles and Practice of Banking” defines it, “A banker is a dealer in capital or more properly, a dealer in money. He is an intermediate party between the borrower and lender. He borrows of one party and lends to another.” Dr. Herbert L. Hart describes it as, “the acceptance of deposits' of funds withdraw able on demand is the essential function of a banker”

Banker-Customer Relation 

In India and Pakistan this definition has been formulated under the “Negotiable Instrument Act, 1881”, which was amended in 1962 by Banking Companies ordinance by the Govt. of Pakistan, that says, “Banking means the accepting, for the purpose of lending or investment of deposits of money from the public , payable on demand or otherwise, and withdrawable by cheques, draft, orders or otherwise”

Functions of a Banker/Bank 

Banking Company means , any company which transacts the business of banking in Pakistan. Other Essential Functions are, 

• Borrowing and Lending of money 

• Discounting Bills of Exchange and other Negotiable Instruments 

• Collecting Negotiable Instruments on behalf of customers 

• Buying and Selling Bullion and foreign exchange 

• Granting of Letter of credit to the customers 

• Receiving Valuables for Safe custody 

• Underwriting and dealing in Stock, shares, Debentures and other Securities on behalf of customers.

• Acting as an agent to customers, undertaking and executing Trust 

• Carrying on Guarantee and Indemnities business 

• Dealing with any property that may come to it as Security in satisfaction of its outstanding claims 

• Acting as Mudharaba Company 

• Undertaking the administration of estates as executor, Trustee, or otherwise.

What constitutes A Customer

Customer: in the law we cannot find any specific definition for the customer. However, it is generally believed that “anyone conducting or dealing with banking transactions is called customer.” The only reference can be found in Section 131 of the “Negotiable Instruments Act of 1881.

Wherein protection has been given to a banker, collecting cheques on behalf of his customers. However, in a court judgment (Siddiqui A. H., 2007), it describes, the word Customer signifies a relationship in which duration is not of the essence, “A person whose money has been accepted by the bank on the footing that they undertake to honor cheques up to the amount of his credit

Qualification of A Customer

The Relationship between banker and customer is purely a contractual one. This contract is formed under Section 3 of the contract Act 1872, which describes as follows: 

• He should be grown up and conscious person 

• Should be a person of sound mind under 12 of the contract Act. 

• He shall not have been debarred from entering into contract under any Law.

Rights and Duties/Obligations of a customer

Rights:

• To draw cheques against his credit balance, or in the absence of credit balance 

• To receive a pass book or a bank statement containing a copy of his account with the banker 

• To sue the bank for the cost, loss, and damages when his cheque is wrongfully dishonored. 

• To sue when the banker has not maintained the secrecy of accounts 

• To claim for and receive profits /returns on his deposits as promised by the banks 

Duties / Obligations

Customer has to satisfy some obligations in turn of the services and products he receives from the banker 

• Under section 72 of the Negotiatiable Instrument Act 1881, the customer must present the cheques for payment and collection within the business hours of the banker 

• Section 84 of the Act, it is customer's duty to make sure the cheques and other instruments are presented in a reasonable time from the date of issue. 

• He himself is responsible for the safety of his cheque book and other instruments 

• He should draw his cheques carefully to keep no room for fraudulent alterations and additions.

General relationship of Banker & customer

Generally this relationship is primarily of Debtor and Creditor relationship. (Customer/Creditor—Bank/Debtor—Borrower 

• This relation also implies the Principal-Agent relation, where the customer is entitle for profits derived from his deposits. 

• Balior and Bailee Relationship– section 148 of the contract Act defines, “A bailment is delivery of goods by one person to another for some purpose.” 

• When banker provides safe custody or facilities to the customer the relationship becomes Bailor and Bailee. In this case the customer is Bailor and Banker is Bailee.

Banking Law & Practice Lecture No. 8

 Special Features of Banker's Duty of Secrecy

 The banker/customer relationship is confidential. A banker must maintain secrecy about customer's account. Section 33-A of banking companies Ordinance, 1962 makes obligatory for bankers to maintain secrecy and fidelity of customers accounts except in permitted situations. 

Under nationalization Act 1974 section 12(1) also makes it obligatory for banks to keep secrecy of customers” accounts. However there are some exceptions to this obligation. 

1. Under Compulsion of Law: 

2. Evidence needed in the court of Law, section 6 of the Banker's book Evidence Act, 1891 permits the banker to produce certified copies of the Entry book.

Exceptions to Obligations of Secrecy 

Section 144 of the income tax Ordinance 1979, the income tax commissioner or officer can inspect the bankers” books with prior permission. 

2. Duty to public to Disclose: sometimes it is obligatory for bankers to disclose the nature and operations of accounts in the larger interests of public during national emergencies. Suitable disclosures about unsatisfactory and suspicious nature and operations of accounts but it is banks responsibility to make sure everything is legally correct according to the law.

3. In the Interest of the Bank: When the bank sue their customers to recover their loan or overdraft accounts, the bank may also disclose the nature of account to defend itself against the charges. 

4. Express or Implied Consent of Customers: customer may permit the bank to supply certain information for balance sheet or sending periodic statements to some professional adviser for certain period. (Justice Atkin in Tournier case 1924, IKB)

Termination of Relationship 

As the banker—customer relation is contractual and may terminated by any one of the two by serving a notice on the other. Customer may terminate this relationship by closing down his account on any of the following ground; 

1. Change in residence, the customer may not maintain his account from the new place. 

2. Not satisfied with products and services provided by the bank, the unacceptable behavior of banking staff, inefficiency in service delivery and incomplete information and delayed bank statements and other information.

3. Death of a customer may lead to account closure. The law does not authorize the heirs to operate the account of a deceased person, The account is closed down and the credit balance is paid to the heirs of the deceased person according to the law of the land.